“I can have a 529 plan AND a Coverdell? I’m so excited, this is like the all-you-can-eat-buffet of college savings!”
Don’t start stuffing dinner rolls into your pockets just yet. If saving for college is a buffet, the Coverdell Education Savings Account, or ESA, is like going up for seconds (or thirds, depending on how well you’ve saved).
Your Coverdell works much like your 529 plan: your after-tax contributions grow tax-free and your withdrawals are also tax-free as long as they’re spent on qualifying educational expenses. However, unlike your 529, your Coverdell withdrawals aren’t limited to higher-education costs. You can spend your savings on private elementary or high school tuition, required uniforms and textbooks, extended day programs, and special-needs services for students with disabilities. Withdrawals for non-qualifying expenses- like afterschool karate classes or the gas money to drive your child to school- are hit with income taxes and a 10% penalty.
Hungry for a Coverdell yet? There are a few caveats: you (or a loved one) can only sock away $2,000 a year per child, even if that child has multiple Coverdell accounts. If you try to overstuff your account, the IRS will slap your hand away from getting Coverdell seconds via a 6% penalty. (Still less embarrassing than the time Gram got scolded at The Olive Garden because, actually, there is a limit to unlimited breadsticks.)
You can only fund a Coverdell until the beneficiary turns 18, and your child must spend down the account by the time he/she reaches 30. After 30, the account is liquidated and distributed to your child… and if you haven’t guessed already, that remaining cash is subject to income tax (at your child’s tax bracket) and a 10% penalty.
With a Coverdell, you’re technically not the custodian of the account – that would be the bank or financial firm with whom you opened the account – so you don’t have the same level of control as you would with a 529. However, if Junior isn’t college-bound, you can still rollover the account to another family member.
If your adjusted gross income exceeds $110,000 as a single filer or over $220,000 on a joint return, you're ineligible to contribute to a Coverdell. But if you're determined to sneak past the buffet manager, you can gift the money to your child first and then the child can contribute to his/her Coverdell.
Photo: Gideon Tsang
This article is 2nd in the How to Save For College Series